Several colleagues have asked me whether and when I intend to comment on the Hon Tang’s AG CJHC judgment in the case of Commissioner of Inland Revenue v CG Lighting Limited; the unwillingness of the Inland Revenue Department (“the Department”) to consent to CG Lighting Limited’s (“CGL”) application for leave to appeal to the Court of Final Appeal (“CFA”) being as of right; the Court of Appeal’s refusal to grant leave to appeal to the CFA, and the Committee of the Court of Final Appeal’s (“Appeal Committee”) refusal to proceed with an appeal to the CFA.
The Appeal Committee’s determination was issued on 24th August 2011 and, for the first time in 16 tax appeals to the CFA, leave to appeal was refused. To be honest, it has taken me two months to be objective as opposed to venting my thorough disgust at the action of the Department and the judiciary system.
Let me go back to the beginning of this saga. CGL structured its affairs in accordance with paragraphs 15 and 16 of the Inland Revenue Department’s Departmental Interpretation and Practice Notes (“DIPN”) No.21 (Revised) issued in March 1998 (a revised version of DIPN21 was subsequently issued in December 2009). CGL’s objective was to take advantage of the 50% tax concession given by the Department to Hong Kong taxpayers who manufactured their products in both Hong Kong and Mainland China. Paragraphs (15) and (16) DIPN 21 provided that:
“(15) A Hong Kong manufacturing business, which does not have a licence to carry on a business in the Mainland, may enter into a processing or assembly arrangement with the Mainland entity. Under these arrangements, the Mainland entity is responsible for processing, manufacturing or assembling the goods that are required to be exported to places outside the Mainland. The Mainland entity provides the factory premises, the land and labour. For this, it charges a processing fee and exports the completed goods to the Hong Kong manufacturing business. The Hong Kong manufacturing business normally provides the raw materials. It may also provide technical know-how, management, production skills, design, skilled labour, training and supervision for the locally recruited labour and the manufacturing plant and machinery. The design and technical know-how development are usually carried out in Hong Kong.
(16) In law, the Mainland processing unit is a sub-contractor separate and distinct from the Hong Kong manufacturing business, and the question of apportionment strictly does not arise. However, recognising that the Hong Kong manufacturing business is involved in the manufacturing activities in the Mainland (in particular in the supply of raw materials and the training and supervision of the local labour) the Department is prepared to concede, in cases of this nature, that the profits on the sale of the goods in question can be apportioned. In line with paragraphs 21-22 below, this apportionment will generally be on a 50:50 basis.”
CGL had always described its principal business activity to be that of a manufacturer, and its audited accounts have reflected that CGL owned all the unused raw materials, unfinished products and finished products at the factory. The factory was owned by its wholly owned subsidiary, CGES, in the PRC, and CGL provided the factory with all the raw materials, technical know-how, management staff, production skill, computer software, product design, skilled labour, family, supervision and the manufacturing plant and equipment. CGL did not charge for the provision of this assistance. There were no sales and purchase agreements between CGL and the factory – CGL merely paid the factory a processing fee.
However, every DIPN comes with the following health warning:
“These notes are issued for the information of taxpayers and their tax representatives. They contain the Department’s interpretation and practices in relation to the law as it stood at the date of publication. Taxpayers are reminded their right of objection against the assessment and their right of appeal to the Commissioner, the Board of Review or the Court are not affected by the application of these notes.”
Nonetheless, I had always assumed that any reasonable person would expect that reliance could be placed on the information provided by the Department in its own DIPNs, otherwise what is the point in publishing them? Hence it came as a complete surprise to the taxpayer, the taxpayer’s counsel and to myself that Mr Eugene Fung, Counsel for the Commissioner of Inland Revenue (“CIR”), stated at the commencement of the Board of Review (“BOR”) hearing that the CIR was not bound by its own concession set out in DIPN21 and that the case should be determined on established source principles.
The BOR was then faced with a need to establish the facts and, based on its findings, to determine:
(1) what the operations of CGL were that produced the relevant profits, and
(2) where those operations took place.
The BOR reached the determination that:
“In respect of the first question, the profits in question did not arise from a trading operation, as contended by the CIR. With respect, such contention is premised upon the Company D documents and ignores a raft of materials produced by the Taxpayer to demonstrate otherwise.”
However, whilst rejecting the contention that CGL was a trader, the BOR equally rejected the contention that CGL was a manufacturer. In the BOR’s words:
“This is a case where the Taxpayer was a seller of Product J which it designed and participated in their production… We believe that in a case, like here, where the operation is a multi-facet one, this Board must have regard to the commercial reality. Such reality dictates that the Taxpayer’s participation in the production process was as much as part of its profit-producing transaction as the obtaining of a purchase order.
Plainly, part of the Taxpayer’s profit making transactions was located in the Mainland and therefore its contention that part of its profits was sourced from outside Hong Kong and not chargeable to profits tax is correct.”
The BOR remitted the case back to the CIR for apportionment.
This was a determination that everyone, other than the CIR, had hoped for. It was an accurate reflection of the facts and the evidence given by CGL. It reflected the practice that the CIR had adopted for many years and on which CGL had relied and had arranged its affairs.
The CIR appealed the decision to The High Court of the Hong Kong Special Administrative Region Court of First Instance. Benjamin Yu SC, Counsel for the CIR, submitted that:
(1) the BOR had erred in law by failing to focus on the geographical location of the actual profit-producing activities of CGL, i.e., the sale of goods, and
(2) the activities undertaken by CGL outside Hong Kong were antecedent or incidental and therefore legally irrelevant.
(3) In the light of (2) above;
“Having taken into account antecedent or incidental matters that are legally irrelevant, the Board’s conclusion that the source of the Taxpayer’s profits was partly Hong Kong and partly outside Hong Kong is one which no reasonable tribunal properly directed could reach.”
In the court of First Instance, the Hon Fok J, having reviewed the BOR’s decision and relevant case law, concluded that:
“It is necessary to recognize that the Board in the present case found that CGES was the manufacturer and did not find that CGES was an agent of the Taxpayer in the production of the lighting fixtures. This is a material finding and is not affected by the fact that, because of the relationship between it and the Taxpayer, CGES only received a processing fee which was no greater than its operating cost and overheads.
Once it is accepted that the manufacturer of the lighting fixtures was CGES and not the Taxpayer and that CGES was not the agent of the Taxpayer in the manufacturing process, I do not see that it is possible to avoid the conclusion that the activities of the Taxpayer in relation to the manufacturing process itself are simply antecedent or incidental to the profit-producing transactions here.”
Hence Fok J found for the CIR on the basis that CGL was not the manufacturer and that the activities that CGL undertook to support the manufacturing process were “antecedent or incidental”. Incidentally, the question of CGES being an agent for CGL was not raised in the BOR. Whilst the judgment was extremely clear and well written, it left the general public clearly confused.
Following Fok J’s decision, a parent company that owns all the raw materials and finished goods located at a factory owned by a third party, and that is responsible for every facet of the manufacturing activity, cannot be considered to be significantly involved in the manufacturing of its own products, notwithstanding the fact that Fok J accepted that there were no sales and purchase activities between CGL and CGES and that CGL simply paid CGES a processing fee for the manufacture/assembly of its products. Therefore are we to assume that the word “manufacturer” can only be applied to the person who physically owns the factory?
I strongly believe that the Counsel for the CIR was surprised that he was successful at the Court of First Instance, particularly as Fok J appears to have based his decision on Counsel’s secondary submission that no reasonable person could conclude that CGL was the manufacturer. CGL appealed the case to the Court of Appeal and sought to establish that Fok J had:
a) not understood the reality of CGL’s case and that the involvement of CGL in the manufacturing process was not “antecedent” or “incidental”;
b) substituted his own view of the facts as opposed to the determination of the facts found by the BOR;
c) adopted an incorrect legal analysis of the facts found by the BOR, and
d) incorrectly concluded that the BOR’s decision was unreasonable.
The judgment of Court of Appeal was delivered by the Hon Tang Ag CJHC. In my opinion it must rank as one of the poorest judgments regarding taxation that I have read. The judgment simply reiterates the facts, attempts to interpret the facts in a manner inconsistent with the decision of the BOR, and makes no attempt to independently analyse the law other that to express the view that the BOR might have reached a different decision had the case been heard after the Court of Appeal’s decision in CIR v Datatronic [2009] 4 HKC 518, a case heard by the Hon Tang Ag CJHC himself. An example of this can be found in paragraph 21 of the judgment:
“The Board’s finding that the reality of the transaction between CGES and the Taxpayer was that there was no sale of the finished products by CGES to the Taxpayer was not challenged on the case stated. It is therefore not something with which we are required to deal. The implication of the Taxpayer’s case appeared to be that all the raw material supplied by the Taxpayer to CGES as well as the finished products belonged to the Taxpayer throughout. However, I do not wish to give the impression that I agree with the Board’s finding. With respect, what the Board referred to as the reality of the situation probably only represented the subjective intention of the Taxpayer, namely, that for Hong Kong tax purposes it should be regarded as the owner of the raw material and the finished products. That is presumably because the Taxpayer thought that from the Hong Kong tax liability point of view it would be advantageous that its transactions with CGES should be not regarded as a sale of the finished product by CGES to the Taxpayer. I doubt whether the ownership of goods could solely depend on the subjective intent of the Taxpayer. But, as I have said, this is not something we need to decide.”
It therefore came as no surprise that the appeal was dismissed. In my view, one would be forgiven for thinking that the judgment was given on the assumption that the case would be appealed to the CFA where the facts would be reviewed together with the decision of the BOR, the decision given by Fok J in the Court of First Instance and the relevant case law in order to provide much-needed guidance on the location of the source of profits made by Hong Kong taxpayers from manufacturing in Mainland China by way of a processing agreement with a third party.
Nobody was under the illusion that Tang Ag CJHC would find in favour of the taxpayer. It was always anticipated that the case would need to be heard by the CFA, which would normally seek to have a UK judge specialising in taxation sitting on the bench.
However, when the CIR was asked to consent to CGL’s application for leave to appeal to the CFA, being as of right, the CIR refused. Of the 16 tax cases that have previously been appealed to the CFA, the CIR has given consent on each occasion. Again, one would be forgiven for believing that the CIR had been advised that the CFA had decided to restrict the number of cases to be heard before it, and certainly taxpayers should not consider that the CFA was obligated to hear tax appeals. Clearly, the progress of the case relating to Nina Wang’s estate would have endorsed the view that the CFA intended to take a harder approach to adding to its case load.
The application for leave to appeal to the CFA was referred back to the Court of Appeal for its approval. The Hon Tang Ag CJHC dismissed CGL’s application for leave to appeal on the grounds that the application did not satisfy the provision of Section 22(1)(a) or 22(1)(b) of the Hong Kong Court of Final Appeal Ordinance.
Section 22(1)(a) allows a case to be heard by the CFA “as of right” in a civil matter where the amount in dispute amounts to the value of HK$1,000,000. The second option is where the Court can, at its discretion, allow the appeal on the basis that it is a question of great general or public importance or the Court otherwise believes the appeal ought to proceed.
The Hon Tang Ag CJHC was of the opinion that the tax in dispute was similar to the assessment of unliquidated damages and therefore did not satisfy Section 22(1)(a). With regard to Section 22(1)(b) Tang was of the opinion that the law had been correctly applied by referring to the CFA’s decisions in Ing Barings & Securities (Hong Kong) Limited v CIR (2007) to HKCFAR 417 and Ngai Lik Electronics Co. Ltd v CIR (2009) 12 HKCFA 296. Tang further stated that:
“It is said that we have misapplied or misunderstood the decisions. Even if that is right, that is not a question of great general or public importance … In any event, the solution is not leave to appeal to the Court of Final Appeal but legislation.”
Leave to Appeal to the CFA having been dismissed by the Hon Tang Ag CJHC, CGL’s remaining option was to appeal directly to the Leave Committee of Court of Final Appeal. In his determination, Mr Justice Bokhary PJ stated:
“Monetary claims which require assessment – and are therefore unliquidated rather than liquidated – do not come within S22(1)(a). Tax requires assessment. So tax demands do not come within S22(1)(a). The appeal which the taxpayer seeks to bring does not lie as of right.”
As Mr Justice Bokhary PJ was also of the opinion that there was no legal principle to be resolved, leave to appeal was refused and so the case became final without a satisfactory conclusion.
Several very interesting issues arise from this. Firstly, nowhere in S22(1)(c) is reference made to liquidated damages. If such a phrase was used, I disagree that a person’s tax liability could be described as “unliquidated”, as it has already been assessed and quantified. At the appeal hearing, the Court asked whether it should be “harried” with every tax dispute appealed from a lower court, a view enhanced by the CIR, who suggested that hearing tax appeals, as of right, would open the “floodgates” for tax litigation. My answer to this is quite simple – is that not every taxpayer’s right? Why should a taxpayer’s right of appeal be prejudiced by the apparent workload of the CFA? Equally, I was very surprised that the CIR and Mr Justice Bokhary PJ concluded that this case was not of “general or public importance”, when every tax professional, manufacturing association and manufacturer had followed this case with great interest.
In my opinion, this was a very distasteful end to an unsatisfactory case.
